What Are ETFs?

Exchange traded funds (ETFs) offer the best of two worlds: equity and mutual fund investing. ETFs can do this because they trade on exchanges like equities, but are structured to mirror market indexes, thereby relieving you of active portfolio management, at least in regard to a particular investment.

ETFs are a variant of index funds in that they are usually passive vehicles that represent a basket of stocks that mirror an index. The difference is that unlike an index fund, an ETF trades on a stock exchange in real time.

ETFs have several advantages over typical mutual funds:

Advantage 1: Many mutual funds have investment minimums and early redemption fees; with ETFs, there's no such thing.

Advantage 2: Real-time tracking. Mutual funds only give one price at the end of the day. ETFs price all day long.

Advantage 3: Real-time trading. Mutual funds can only be bought and sold at the end of the day. ETFs can be bought and sold whenever the markets are open.

Advantage 4: Cost. Mutual funds aren't cheap - the management behind them comes at a price. For the most part, ETFs are cheaper than the average mutual fund.

Advantage 5: Transparency. Mutual funds are only required to disclose their holdings once per quarter. In an ETF, you always know what you own on any given day.

ETFs allow you to invest in an index, an industry, or even a whole sector, without having to pick specific stocks. So, with an ETF, if you believe a particular sector will perform well, you can invest in it without the fear of picking the one stock in the group that underperforms. Of course, understanding sector rotation could be beneficial in that scenario.

This theoretical model is based on Sam Stovall's S&P's Guide to Sector Rotation and states that different sectors are stronger at different points in the economic cycle. The graph above shows these relationships and the

order in which the various sectors should get a boost from the economy. The Market Cycle precedes the Economic Cycle because investors try to

anticipate economic effects.

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Stage: Full Recession Early Recovery

Consumer Expectations: Reviving Rising

Industrial Production: Bottoming Out Rising

Interest Rates: Falling Bottoming Out

Yield Curve: Normal Normal (Steep)

Stage: Full Recovery Early Recession

Consumer Expectations: Declining Falling Sharply

Industrial Production: Flat Falling

Interest Rates: Rising Rapidly (Fed) Peaking

When the contentious US election finally ended, attention turned to the likely policy implications of the altered political landscape of Donald Trump. In some ways, the Republican victory in November will translate into a 180-degree turn from the status quo under the Obama administration.

But, as with any major shift, there will be industry winners and losers. We have already seen a sharp sector rotation. One of the key questions for investors over coming months will be whether this Trump sector trade has already played out.

So what have we seen so far? On the downside, bond proxies – stocks that offer some of the same qualities as fixed income – have suffered from a rise in the yield on risk-free Treasuries.

In contrast, industries that stand to benefit from lower regulation have been the main winners. Financial services top the charts with a gain of over 10%.

While the aggressive sector rotation may have run its course, we still believe the “Trump Trade” has a long way to go. For our list of ETFs, we simply started with the funds that have performed near the top since the election.

We then cross-referenced those ETFs with a list of the funds where institutional money is flowing into them, whereas before the election money was flowing out. When referring to institutional, or “smart” money, investors and traders are referring to the money of institutional investors. So, who are the institutional investors?

Financial institutions, such as investment funds and insurance companies, are the large players in the stock market. They also include investment banks, retirement or pension funds, hedge funds, investment advisors and mutual funds. These are considered to be the informed investors.

When it was all said and done, we ended up with the following (8) ETFs that you might want to add to your portfolio.

SPDR S&P 500 ETF (SPY)

Yield Curve: Flattening Out Flat/Inverted

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Being that the overall market should perform well, at least initially, buying the small-cap Russell 2000 ETF makes great sense. Money-flow went from positive 1.35% last quarter to a positive 11.5% this quarter.

PowerShares Nasdaq (QQQ)

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When the market is strong, and performs well, the technology space tends to outperform. So, “the Qs” is the ETF to buy. Money-flow grew from positive 7% last quarter to positive 26% this quarter. That’s a big jump in “smart” money.

SPDR S&P Bank ETF (KBE)

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As mentioned above, financials have hit the jackpot with a Trump presidency. Of course, one look at the chart above should tell you that. The KBE has had two consecutive quarters on increasing institutional money flow.

The ETF seems a bit extended here, but the recent pullback could provide a nice entry for more gains.

iShares MSCI Mexico ETF (EWW)

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With all the rhetoric and tensions flying around in regards to U.S. – Mexico trade relations, one would think the EWW would be getting crushed. Nope.

That is two very nice, back-to-back quarters in positive institutional money flow.

iShares U.S. Energy ETF (IYE)

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As mentioned above, energy overall should get a mega boost from Trump policies, and the IYE is a bit broader than others. Money-flow went from negative 8.6% last quarter to a positive 7% this quarter.

This ETF is a bit more “slow and steady”, but the recent consolidation should lead to further gains.

iShares MCSI China ETF (MCHI)

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Like the EWW, investors might think that any ETF relating to China would be seeing a flight of institutional money. However, as you can see, the big money has been flowing into the MCHI for two straight quarters.

The ETF has finally pulled back a bit, which may have provided investors with a more desirable entry point.

iShares MSCI Europe Financials ETF (EUFN)

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Of course, if the big institutions think the financial sector is the place to be, they’re certainly not going to confine themselves to just the U.S. banks.

The EUFN jumped from a 15% increase in institutional money flow, to a whopping 86% increase!

Vectors Russia ETF (RSX)

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Whether you agree with it or not, perception has it that Trump and Putin are going to be bosom buddies. The RSX seems to reflect that belief very well, in investors’ minds. Money-flow has seen repeated quarters of smart money taking hold.